Service firms win out

The small end of the market emerges a relative winner in the Henry tax review, with the bigger miners expected to pay for other incentives aimed at smaller companies.

The federal government plans to levy a 40 per cent resources super tax to fund a lift in retirement contributions to 12 per cent from 9 per cent, cut the corporate tax rate to 28 per cent from 30 per cent, provide tax incentives for exploration activities and improve depreciation charges on capital equipment.

Now more than ever, the best way for investors to gain exposure to the resources boom could be to buy engineering services companies that provide specialist skills for mineral and energy exploration as they are further removed from the mining super tax and would stand to gain from any pick-up in exploration activity.

But Celeste Funds Management chief investment officer Frank Villante notes that not all mining services firms will benefit. In fact, some could actually lose out.

“In the post-Henry world, the question is what is the level of skill that is required because for some mining companies there might be an advantage to bring the capital that is off balance sheet [to pay for services] back on balance sheet," Mr Villante said.

“For example, if the skill that is provided by the outsourced company is to move dirt from point A to point B, then the level of [expertise] may be relatively modest compared with a company that provides engineering services to build plants and infrastructure or chemical testing."

The type of companies he believes will benefit include mineral processing and maintenance engineering firm
Lycopodium
, laboratory services company
Campbell Brothers
and temporary accommodation builders
The MAC Services Group
and
Fleetwood Corporation
.

These companies provide services and products that are difficult for resources companies to develop on their own. But Mr Villante suspects mining equipment rental companies and general engineering contractors may not be so lucky as there could be tax advantages for miners and oil and gas companies to take these in-house.

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“If you are [equipment rental company] Emeco or Boom Logistics, life may not have gotten better for you. The same goes for [general contractors]
Macmahon Holdings
or
NRW Holdings
," he said.

The head of research for Perth-based financial firm Argonaut, Ian Christie, holds a similar view although he warns that specialist engineers may not see much benefit in the near-term.

“If there was a sub-sector that would benefit it would be the exploration side of the market, such as the drillers. But I think it is going to take some time for the response to the Henry review to be digested by companies, and by us, just to see where things are headed next," Mr Christie said.

“The biggest danger is that there will be a deferral of projects as [resources companies] try to work out the impact of the changes."

He also believes that resource services stocks are now generally fairly priced and that there are only a few pockets of value left in the market.

Two stocks he rates as “buys" are drilling companies
Ausdrill
and
Swick Mining Services
. The former recently completed a $103.7 million capital raising at $2 a share to fund to organic growth following its Brandrill acquisition.

Argonaut noted that Ausdrill is well positioned to win a number of significant contracts in the gold, coal and coal seam gas industries both in Australia and Africa.

Mr Christie is forecasting an 18.3 per cent jump in annual revenue for the current financial year and a further 24.1 per cent increase to $742.6 million in 2010-11 as normalised net profit nearly doubles to $58 million over the two years.

Swick is also forecast to deliver solid double-digit revenue growth for the current and next financial years of 25.1 per cent and 32.3 per cent to $138.5 million, respectively, Mr Christie said.

The firm had to complete a capital raising as well earlier this year as the rebound in rig utilisation has placed stress on its working capital with operating cash flow came in at a meagre $70,000 in the first half of 2009-10.

Swick had 45 rigs in the field on December 31 and that number is expected to rise to 63 rigs at work by the end of this financial year.

Argonaut has a price target of $2.80 on Ausdrill and 55¢ on Swick.

Other small cap winners from the tax review are asset managers and financial planners as the 3 per cent lift in compulsory superannuation is expected to provide a windfall to the sector. This will only add to the appeal of fund managers like IOOF Holdings and accountancy and financial planning groups like WHK Group and Count Financial, noted Celeste’s Villante.

But the potential threat to the latter two could come from the potential simplification of tax returns, with the government not ruling out bold initiatives to automate a large part of this process. This could lead to less dependence on accountants at a time when the government is also looking into curbing fees and incentives for the financial planning industry.

Mr Villante is not too concerned about the simplification of tax. “It’s a cynical view on my part. I do fundamentally believe that tax over time doesn’t get any less complicated – it gets more complicated. The history of tax systems over the last 400-plus years suggests that that’s the case."